UK PMI numbers ease pressure for a 50bps interest rate rise

Today’s PMI numbers may have tipped the balance for a smaller 25bps rise only

By Stuart Cole | @Stuart Cole | 24 July 2023

City of London

The softer July flash PMI numbers for the UK this morning will further increase expectations that the Bank of England (BoE) will increase interest rates by just 25bps at the next meeting of the Monetary Policy Committee (MPC) on 3rd August, as opposed to the larger 50bps hike predicted after the strong wages growth numbers released on 11th July. From a peak of approximately 83%, the chance of a 50bps hike now being delivered has fallen to just 34%, highlighting how the weaker data published since then – namely the CPI figures and today’s PMI readings – are weighing on market sentiment and increasing opinion that the monetary tightening delivered by the BoE is finally starting to have an impact and drag on economic activity.

Today’s over-arching Composite reading fell to 50.7, its lowest reading since January, and marking the third consecutive month of decline. Positioned so close to the neutral 50.0 level, it is now in territory consistent with UK GDP growth holding steady only, ie showing no growth, the reality of which was already highlighted by the output figures released last week which showed growth in May to be flat. Worryingly, the picture being painted going forward does not look promising either, with the new orders component falling to 50.0 from 51.6 in June and suggesting there is little momentum behind growth at the moment. Outstanding work backlogs were also reported as being depleted at a fast pace, reinforcing the message that companies are struggling to find new work and instead increasingly relying on outstanding obligations to maintain production levels. The clear implication is that if nothing changes, then activity will soon fall into contractionary territory as these backlog orders are exhausted.

For the MPC, signs of a slowing economy will be welcome, as they point to the potential for easing inflationary pressures. But the bugbear is, once again, the labour situation. Today’s numbers showed that companies are continuing to hoard labour, the composite employment still above its long average level of around 50.7 despite falling from 52.5 to 51.6. The hoped for softening in the labour market is not materialising and until firms start to shed labour there appears little prospect of wages growth materially weakening.

Also of concern to the MPC will be the pricing measures. Output prices, despite falling from 58.6 to 56.0 – the lowest reading since Q1 2021 - remain significantly above their long-term average level of 50.7, while input prices fell only slightly, as input inflation in the services sector continues to remain stubbornly high on the back of strong wages growth. Although the overall picture is one of pricing pressures easing, they are falling only slowly and given the experience of core CPI this year, which began to increase steadily in January after four months of moving lower, the MPC will not want to take any chances in letting the inflation genie potentially escape the bottle again.

Overall, today’s numbers show an economy that is holding up in the face of still rising prices and tightening monetary policy, but one that is starting to buckle under the weight of both these things and heading towards stagnation at best, contraction at worse. For the MPC, a decision to raise interest rates again next month remains certain still. But when weighing up the merits of a 50bps hike – strong wages growth and robust retail sales numbers – as opposed to a 25bps hike – both headline and core CPI printing softer than expected – today’s PMI numbers could help to tip the balance in favour of just a 25bps rise.